NEW YORK - Randal Quarles may have passed his first stress test. The U.S. Federal Reserve’s supervisory chief is proposing to use its annual fitness exam to determine how much of an extra capital buffer the nation’s 30 largest lenders need. The change would reward good risk management and streamline the complex process while maintaining, or slightly raising, reserves at major lenders. That should spell relief all around.

Banks have been looking for a lighter touch ever since President Donald Trump last year tapped Quarles to become the Fed’s vice chairman for supervision. A former Treasury official in the George W. Bush administration and executive at private equity shop Carlyle, he is sympathetic to the argument that the raft of regulations imposed following the 2008-09 financial crisis have hamstrung banks and curbed lending growth.

In December, he proposed loosening the reins a bit by giving banks some details in advance of the stress tests. Lenders would as a result be privy to the watchdog’s estimated loss rates for certain types of loans and its assumptions about housing prices under various downturn scenarios. That should make it easier for banks to prepare for the exam – and avoid an embarrassing fail that could force a dividend suspension – without enabling them to game the process.

Quarles aims to strike a similar balance with Tuesday’s proposed overhaul of capital standards, the first since the Fed tightened them dramatically after the crisis. It would replace the existing capital conservation buffer, set at a uniform 2.5 percent of risk-weighted assets, with a charge tailored for each institution depending on the results of its stress test. For example, if under the worst economic scenario a bank was projected to lose 3 percent of its common equity Tier 1 capital, it would be slapped with a 3 percent stress capital buffer for the coming year.

The idea was first proposed in 2016 by his predecessor, Daniel Tarullo, who worried that regulators had tacked too many add-ons to the capital regime. Under the new plan, large banks would have to meet 14 capital-related requirements, down from 24 currently. The change would maintain or “somewhat increase” capital at the eight biggest U.S. banks while decreasing it modestly for smaller lenders, the Fed reckons.

With the recovery entering its ninth year and lending standards at their loosest since before the crisis, relaxing rules now could encourage reckless behavior. At the same time, American banks are healthy and have boosted capital by a collective $720 billion since 2009. By giving banks a financial incentive to keep excessive exuberance in check, Quarles’ compromise should ease the stress for bankers and their overseers.

CONTEXT NEWS

- The U.S. Federal Reserve on April 10 proposed the introduction of a “stress capital buffer” that would link a part of banks’ capital requirements with their performance on the central bank’s annual stress test.

- The change would reduce the number of capital-related requirements that banks have to meet. It is also expected to “generally maintain or somewhat increase” the amount of capital required to be held by the eight largest U.S. banks while decreasing the amount “modestly” for smaller institutions subject to the tests, which apply to lenders with more than $50 billion in assets.

- The proposal “significantly simplifies our capital regime while maintaining its strength," Fed Vice Chairman for Supervision Randal Quarles said in a statement. Banks have 60 days to respond to the proposal.

(Editing by Antony Currie and Katrina Hamlin)

© Reuters News 2018